Albert Edwards Sees Overconfidence In Forward Rates

The US stock market has almost fully recovered from its mid-month drawback now that continued QE seems to at least be on the table, and not only is Societe Generale strategist Albert Edwards troubled by ‘grotesque, QE-fuelled market overvaluation’ he thinks that investors are overconfident in central banks’ ability to keep a lid on the business cycle.

“The problem is that, at these stratospheric valuations, the market does not need to suffer an actual recession to see a crash. Like October 1987, just the fear of recession will be enough to trigger a massive market move,” Edwards writes.

A loss of confidence is a central part of Albert Edwards’ ‘Ice Age’ thesis

Albert Edwards points out that five-year implied inflation expectations have fallen sharply in recent months, while the implied expectation of 5y rates in five years’ time have been more stable (though still down since July). This suggests to him that investors can see that inflation isn’t going to pick up soon, but they still trust that the Federal Reserve will find a way out of the QE trap that bears say it has been caught in.

But today’s overconfidence isn’t just a danger to investors five years down the road. If stock market valuations are largely based on trust that the Fed can keep the economy humming along until it reaccelerates naturally, the failure for that to happen, even without an actual recession, could be enough to put investors off.

“A market loss of confidence in policymakers’ ability to control events has always been part of our Ice Age thesis. US inflation expectations in particular will fall an awful long way if investors fear the US cycle is about to fail,” writes Edwards.

Japan, China both heading toward deflation, says Albert Edwards

In addition to not rebounding as fast as anyone would like, Albert Edwards sees the US economy facing serious headwinds from China and Japan. Edwards is losing faith in Abenomics’ ability to permanently end Japan’s multi-decade fight with deflation and expects another round of QE from the Bank of Japan anytime now. The problem isn’t that Japanese corporations aren’t making money, they are, but Edwards isn’t convinced that wage inflation has picked up enough for Abe’s virtuous cycle to be self-sustaining.

And while he acknowledges that China’s quarterly GDP numbers look like the soft landing that investors are hoping for, he is surprised that markets didn’t react to the drop in Chinese CPI from 2% to just 1.6%.